Forewarned is forearmed

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: Even as the subprime crisis scalps another round of victims, one set of institutions have come into sharp focus globally for their performance: credit rating agencies. Regulation has kept their number low, even though arguments do come up, every now and then, in favour of more agencies and greater competition in this field.

In India, rating agencies have not faced a negative glare, at least so far. Low rating penetration, the current depth and breadth of markets for fixed income instruments, and the nascent state of securitisation markets in terms of both size and sophistication—these have all helped perpetrate a sense of complacency. Unfortunately, experience shows you need a crisis to bring about any serious scrutiny of institutions. Indian rating agencies (two of which happen to be significantly owned by global rating majors) need to be proactive in absorbing lessons from the current global scenario for an especially urgent reason. Next fiscal’s compliance with Basel II prudential norms will heighten the role of these agencies in the banking sector. This creates a different level of “implied accountability” at a systemic level. Without getting into the pros and cons of the same here, there would be two entirely different levels of involvement. One, banks will use bank loan ratings by agencies as external ratings under the Standardized Approach of Basel II for determining regulatory capital. Two, under the IRB approach for capital determination, agencies can get involved in diverse ways with banks’ own “internal” ratings of customer exposures. For these so-called “internal” ratings by IRB banks, agencies may supply “validation services”. Reportedly, Indian banks are signing agreements with rating agencies for bank loan ratings for Basel II capital adequacy purposes. The primary principle of Basel II is that capital requirements would be risk-sensitive, with credit ratings used as yardsticks.